3. Net Present Value (NPV) z action-takeQuiz&quiz;_probGuid-QNAPCOA801010000003a

Question

3. Net Present Value (NPV)

z action-takeQuiz&quiz;_probGuid-QNAPCOA801010000003af926e01300008ctx-mayest-00068uck-m ansider this case suppose Black sheep Broadcosting Compeny is evaluating a proposed capital budgeting project (project Alpha) that will require an initial investment of $500,000. The project is expected togenerate the following net cash flows: rear cash Flow Year 1 $300,000 Year 2 $450,000 Year 3 $450,000 Year 4 $500,000 Black sheep Broadcasting Company's weighted average oost of capital is 10%, and project Alpha has the same risk as the firm's average project. Based on the cash flows, what is project Alpha's net present value (NPV) O $824,226 O $947,860 O $1,274,226 $324,226 Making the accept or reject decision Black Sheep Broadcasting Company's decision to accept or reject project Alpha is independent of its decisions on other projects. If the firm follows the NPV method, it should project Alpha which of the following statements best explains what it means when a project has an NPV of $o O when a project has an Npy of s0, the project is earning a rate of returm equal to the project's weighted O when a project has an NPy of s0, the project is eaming O when a project has an NPV of so, the project is earning a profit of so. A firm should reject any project with an average cost of capital. It's OK to accept a project with an NPV of $0, because the project is earning the required minimum rate of return average cost of capital. It's OK to accept the project, as long as the project's profit is positive, Npy of $0, because the project is not profitable a rate of retum less than the project's weighted

Explanation / Answer

Year

Cash Flow(C)

PV Factor Formula

PV Factor(F) @ 12 %

PV(=C x F)

0

$ (500,000)

1/(1+0.10)^0

1.00000

$        (500,000.00)

1

$    300,000

1/(1+0.10)^1

0.90909

$          272,727.27

2

$    450,000

1/(1+0.10)^2

0.82645

$          371,900.83

3

$    450,000

1/(1+0.10)^3

0.75131

$          338,091.66

4

$    500,000

1/(1+0.10)^4

0.68301

$          341,506.73

NPV

$          824,226.49

                             

NPV is $ 824,226.49 or $ 824,226

Hence option “1st $ 824,226” is correct answer.

Based on NPV decision, the project Alpha should be accepted.

A $ 0 NPV means that the investment earns a rate of return equal to the discount rate. If you discount the cash flows using a10 % real rate and produce a $ 0 NPV, then the analysis indicates your investment would earn a 10 % real rate of return. $ 0 NPV project discounted at WACC of company can be accepted as it gives a basic required return.

Hence statement of option 1st best explains about $ 0 NPV.

Year

Cash Flow(C)

PV Factor Formula

PV Factor(F) @ 12 %

PV(=C x F)

0

$ (500,000)

1/(1+0.10)^0

1.00000

$        (500,000.00)

1

$    300,000

1/(1+0.10)^1

0.90909

$          272,727.27

2

$    450,000

1/(1+0.10)^2

0.82645

$          371,900.83

3

$    450,000

1/(1+0.10)^3

0.75131

$          338,091.66

4

$    500,000

1/(1+0.10)^4

0.68301

$          341,506.73

NPV

$          824,226.49

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